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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-21783
NETERGY NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0142404
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2445 MISSION COLLEGE BLVD.
SANTA CLARA, CA 95054
(408) 727-1885
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR
VALUE $.001 PER SHARE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Based on the closing sale price of the Registrant's common stock on the
NASDAQ National Market System on May 14, 2001, the aggregate market value of the
voting stock held by non-affiliates of the Registrant was $20,839,752. Shares of
the Registrant's common stock held by each officer and director and by each
person who owns 5% or more of the Registrant's outstanding common stock have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The number of shares of the Registrant's common stock outstanding as of May
14, 2001 was 26,540,585.
DOCUMENTS INCORPORATED BY REFERENCE
Items 11, 12, and 13 of Part III incorporate information by reference from
the Proxy Statement for the Annual Meeting of Stockholders to be held on July
17, 2001.
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NETERGY NETWORKS, INC.
INDEX
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 12
Item 4. Submission of Matters to a Vote of Security Holders......... 12
PART II
Item 5. Market for Registrant's Common Stock and Related Security
Holder Matters.............................................. 13
Item 6. Selected Financial Data..................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 14
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 31
Item 8. Financial Statements and Supplementary Data................. 31
Consolidated Balance Sheets................................. 33
Consolidated Statements of Operations....................... 34
Consolidated Statements of Stockholders' Equity............. 35
Consolidated Statements of Cash Flows....................... 36
Notes to Consolidated Financial Statements.................. 37
Consolidated Quarterly Financial Data....................... 59
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosures................................... 60
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 60
Item 11. Executive Compensation...................................... 60
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 60
Item 13. Certain Relationships and Related Transactions.............. 60
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 60
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PART I
ITEM 1. BUSINESS
GENERAL
Statements contained in this Report on Form 10-K that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act and Section 21E of the Exchange Act, including, without
limitation, statements regarding our expectations, beliefs, estimates,
intentions or strategies. All forward-looking statements included in this Report
on Form 10-K are based on information available to us on the date hereof, and we
assume no obligation to update any such forward-looking statements. You should
not place undue reliance on these forward-looking statements. Actual results
could differ materially from those anticipated in these forward-looking
statements as a result of a number of factors, including, but not limited to,
those set forth below under the headings "Manufacturing," "Customers and
Marketing," and "Factors That May Affect Future Results" and elsewhere in this
Report on Form 10-K.
Netergy Networks, Inc. and its subsidiaries (collectively, Netergy or the
Company) develop and market telecommunication technology for Internet Protocol
(IP) telephony and video applications. The Company has three product lines:
voice and video semiconductors and related software, hosted Internet Private
Branch Exchange (iPBX) solutions, and Voice-over-IP (VoIP) service creation
software.
During the fiscal year ended March 31, 2001, the Company formed two
subsidiaries, Netergy Microelectronics, Inc. (NME) and Centile, Inc. (Centile)
and reorganized its operations more clearly along its three product lines. NME
provides voice and video semiconductors and related communication software to
original equipment manufacturers (OEMs) of telephones, terminal adapters, and
other edge devices and to other semiconductor companies. NME's technologies are
used to make IP telephones and to voice-enable cable and digital subscriber line
(DSL) modems, wireless devices, and other broadband technologies. Centile
develops and markets hosted iPBX solutions that allow service providers to offer
private branch exchange (PBX) functionality to small and medium-sized businesses
over broadband networks. The Company is developing its third product line, a
VoIP service creation environment (SCE), at the parent company level. This
product is designed for use by telecommunication equipment manufacturers and
service providers.
HISTORY
The Company effected its initial public offering on July 2, 1997 under the
name 8x8, Inc. In August 2000, the Company changed its name to Netergy Networks,
Inc.
The Company began developing its multimedia communication technology in the
form of programmable semiconductors and accompanying software in 1990 and became
a leading manufacturer of semiconductors for the embedded videoconferencing and
videophone markets. The primary customer applications for these semiconductors
were communication terminals (such as videophones, telephones or room
conferencing systems) for the integrated services digital network (ISDN), the
public switched telephone network (PSTN), and IP networks, such as local area
networks (LANs), wide area networks (WANs), and the Internet.
The Company began developing low cost consumer videophones and marketing
these products to consumers under the ViaTV brand name in 1997. The Company
exited the consumer videophone business in the second quarter of the fiscal year
ended March 31, 2000.
In June 1998, using technology designed for its consumer videophone
business, the Company entered the video monitoring market, focusing on security
applications for small businesses. However, the Company determined that its
video monitoring business was not well aligned with its strategic focus on the
IP telephony market and, in May 2000, sold its remaining video monitoring
business to Interlogix, Inc. (Interlogix), a leading manufacturer of security
equipment. Interlogix continues to purchase semiconductors from NME for certain
of its security systems.
The Company entered the market for embedded VoIP telephony products in
December 1998 with the announcement of its Audacity Internet Telephony Processor
(Audacity-ITP). The Audacity-ITP processor
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combines IP telephony protocol support with audio compression/decompression
capability and runs multiple simultaneous IP phone calls on a single integrated
circuit. In April 1999, the Company announced its Netergy Media Hub, an
integrated system product that is based on the Audacity-ITP semiconductor and
that connects up to four analog telephone lines to an IP network. In September
1999, the Company announced its Audacity-T2 IP Phone Processor, which provides
the digital processing required to implement an IP telephone. In November 2000,
the Company announced that it was moving its IP telephony and videoconferencing
semiconductor and embedded software business into a new subsidiary, Netergy
Microelectronics, Inc. (NME). In March 2001, NME announced its Media Hub 2 (MH2)
reference design based on the Audacity-T2, which allows OEMs to manufacture a
gateway system that connects two analog telephone lines to an IP network. NME's
IP telephony products target OEM manufacturers of IP telephony equipment, such
as voice-enabled cable and DSL modems, wireless devices, as well as IP phones
and gateways.
In May 1999, the Company acquired Odisei S.A. (Odisei), a developer of IP
telephony software based in Sophia Antipolis, France. The Company leveraged the
acquisition of Odisei to develop and market a hosted iPBX solution, which uses
VoIP technology to deliver voice services over broadband networks. The hosted
iPBX solution makes use of certain of NME's IP telephony technology and
products, as well as IP phones and other devices developed by third-party
manufacturers. The Company introduced the hosted iPBX in March 2000. In March
2001, the Company announced the commercial release and general availability of
the hosted iPBX solution. In March 2001, the Company also announced that it was
moving its hosted iPBX business into a new subsidiary, Centile, Inc. (Centile).
Odisei will become a subsidiary of Centile.
In June 2000, the Company acquired U/Force, Inc. (U/Force), a developer of
IP-based software applications, including the SCE and a unified messaging
product, based in Montreal, Canada with a consulting office in Hull, Canada. In
the fourth quarter of the fiscal year ended March 31, 2001, the Company
discontinued its Canadian operations and closed the offices in Montreal and
Hull.
INDUSTRY BACKGROUND
Traditional telecommunication networks use a fixed electrical path that
travels through a series of switches across the network. These networks were
designed solely to carry low-fidelity audio signals with a high level of
reliability. Although these networks are indeed reliable for their initially
intended use, these networks are not well-suited to service the explosive growth
of digital communications applications.
Traditional networks transmit data at very low rates and resolutions,
making them poorly suited for delivering high-fidelity audio,
entertainment-quality video or other rich multimedia content. Traditional
networks are also expensive to build because each subscriber's telephone must be
individually connected to the central office switch, which is usually several
miles away from a typical subscriber's location. The digital component of the
traditional telecommunications infrastructure is also less efficient than modern
networks because it allots fixed bandwidth throughout the duration of each call,
whether or not voice is actually being transmitted. Further, it is difficult for
telecommunication service providers to provide new or differentiated services
that the network was not designed to accommodate.
In contrast to the traditional telecommunications infrastructure, data
networks -- such as the Internet or a corporate LAN -- utilize a
"packet-switched" system in which information between two communicating
terminals (for example, a PC downloading a page from a web server) is
transmitted in the form of small data packets that travel through a series of
switches, routers, and hubs across the network. Packet-switched networks have
been built mainly for carrying non real-time data. The advantages of such
networks are their efficiency, flexibility, and scalability. Bandwidth is only
consumed when needed. Networks can be built in a variety of configurations to
suit the number of users, client/server application requirements and desired
availability of bandwidth. Furthermore, many terminals can share the same
connection to the network. The exponential growth of the Internet in recent
years has proven the scalability of these underlying packet networks. The most
common protocol used for communicating on these packet networks is "Internet
Protocol" (IP).
As broadband connectivity has become more available and less expensive, it
is now possible for service providers to offer VoIP services to businesses and
consumers. Providing such services has the potential to both
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substantially lower the cost of telephone and equipment costs to these customers
and to increase the breadth of features available to the end-user. Next
generation services like full-motion, two-way video are now within the bandwidth
available to broadband customers, whether business or residential. To enable
such new products to take hold, service and equipment suppliers need
semiconductor products and software to connect input and output devices to the
networks and to build system functionality.
TECHNOLOGY AND PRODUCTS
The Company has developed a broad range of communication technologies,
including semiconductors, embedded software, system design, telephony call
management software, and VoIP service creation software and related development
tools.
The Company has leveraged its technologies to develop the following product
lines: semiconductors and embedded software designed for IP telephony and
videoconferencing applications, developed and marketed by NME; hosted iPBX
solutions, developed and marketed by Centile; and VoIP service creation
software.
SEMICONDUCTORS AND EMBEDDED SOFTWARE
The Company's subsidiary, NME, develops and markets a range of technology
products, including semiconductors, embedded software, system software, and
reference designs, that allow telecommunication equipment OEMs to build IP
phones and IP to PSTN gateway products and to add IP telephony functions to DSL,
cable, and wireless modems. Additionally, NME provides semiconductors and
embedded software for use in videoconferencing applications. The following
sections describe NME's technology and related products more fully.
Technology
SEMICONDUCTOR ARCHITECTURE -- NME's semiconductors are based on
programmable processor architectures that enable implementation of IP telephony
and videoconferencing applications in a highly efficient manner. NME's
semiconductor architectures employ 32-bit reduced instruction set computer
(RISC) microprocessor cores, which execute the embedded applications software.
Some of NME's semiconductors also employ a 64-bit Single Instruction Multiple
Data (SIMD) digital signal processor (DSP) to accelerate the processing of
signal processing intensive operations.
NME's RISC processor cores use a proprietary instruction set specifically
designed for multimedia communication applications. The RISC cores control the
overall chip operation and manage the input/output interface through a variety
of specialized ports which connect the chip directly to external host, audio,
and network subsystems. The cores are programmable in the C programming language
and allow customers to add their own features and functionality to the device
software provided by NME. The RISC cores access 32-bit instructions and data
through a bus that interfaces to internal and external static random access
memory (SRAM). The RISC core in the Audacity-T2 semiconductor also contains an
extended instruction set to execute specialized DSP instructions.
NME's DSP core architecture is a SIMD processor that implements
computationally intensive video, audio, and graphics processing routines as well
as certain digital communication protocols. The VCP and LVP DSP cores operate at
frequencies up to 72 MHz, the VCPex and Audacity-ITP DSP cores operate up to 80
MHz, the Audacity-T2 DSP core operates up to 150 MHz, and the VP7 DSP core
operates up to 100 MHz. The DSP cores are programmable with a proprietary
instruction set consisting of variable-length 32-bit and 64-bit microcode
instructions that provide the flexibility to improve algorithm performance,
enhance audio and video quality, and maintain compliance with changing digital
audio, video, graphics, and communication protocol standards. The DSP cores
access their instructions through an internal bus that interfaces to on-chip
SRAM and read-only memory (ROM) that is preprogrammed with video and audio
processing subroutines. The combination of RISC and DSP cores can be
reconfigured through a change of application software. This flexibility allows
for the implementation of fundamental processing steps that form the basis of
Media Gateway Control Protocol (MGCP), Session Initiation Protocol (SIP), and
H.323
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standards-based audio telephony systems, as well as H.320, H.323, and H.324
(collectively, H.32x) standards-based video communication systems, all in
embedded software that runs on the integrated circuit device.
EMBEDDED SOFTWARE -- NME has developed a broad range of embedded
application software that runs on its semiconductor products. NME's application
software allows the use of its semiconductors in systems that conform with
various emerging and established international telephony standards for vocoders
and call signaling protocols. By refining its software, NME can enhance quality,
address new standards, and add significant features and functionality to systems
that contain the semiconductor product. In addition, certain customers have
licensed source code to which they add proprietary features and custom
interfaces, and in some cases, port to other semiconductor architectures.
Call signaling protocol stacks are complex software programs required to
make voice calls over IP networks, including the Internet. Vocoders format and
compress digital audio signals and serve as the interface between the old phone
networks and new VoIP networks. Developing and establishing interoperability for
VoIP software requires major engineering resources and significant development
time, which is why many OEMs choose to license it instead. NME's protocol stacks
support the three most commonly deployed VoIP protocols, along with seven
vocoders.
Written in ANSI C, NME's VoIP software is modular and portable, making it
straightforward to use with industry-standard operating systems. It can be
compiled and run unchanged under NME's own POSIX micro-kernel, Linux, and
Solaris. Using a thin translation layer it can be adapted to run on other
embedded operating systems, such as VxWorks and pSOS.
NME's protocol stacks were designed specifically for embedded applications
such as consumer electronics products and terminals, rather than for personal
computers. NME has also designed a compact real-time POSIX micro-kernel, along
with TCP/IP, RTP, and other network services, that provides process scheduling
and communication support services for its protocol stacks and vocoders. This
micro-kernel is appropriate for VoIP devices where a large, costly, real-time
operating system is not practical.
SYSTEM DESIGN -- NME has developed expertise in integrating its
semiconductors and software with peripheral components to produce complete IP
telephony and multimedia communication systems. NME's system technology consists
of modular subsystems that can be combined and rearranged to interface to
various networks (such as POTS, ISDN, Ethernet LAN, wireless, and home networks)
and to various telephony devices, such as the analog phones in a home. NME's
systems are designed and tested to satisfy national and certain international
regulatory requirements such as consumer safety, public telephone network
requirements and electromagnetic emissions.
Products
AUDACITY INTERNET TELEPHONY PROCESSOR -- The Audacity-ITP semiconductor is
designed to support four-port IP based phone terminals and gateways operating
over broadband networks. The Audacity-ITP translates audio signals from analog
telephones into the compressed data format needed for real-time audio
transmission over networks that use packet protocols, including corporate LANs,
WANs, and the Internet.
AUDACITY-T2 IP PHONE PROCESSOR -- The Audacity-T2 semiconductor performs
the digital processing functions required to build an IP phone, including
formatting digital audio data for transmission over packet networks, including
Ethernet, the Internet, DSL links, digital cable systems, etc. The chip can also
be used in two-port media hub or gateway applications.
VERACITY VOIP SOFTWARE -- The Veracity software product provides complex
DSP and protocol functions required in VoIP terminal devices in a documented,
portable software package. The Veracity software can be run on the Audacity
processors or third-party processors.
VP7 AUDIO COMPRESSION ENGINE -- The VP7 audio compression engine (VP7) is a
synthesizable Verilog HDL core that can be integrated into custom semiconductor
designs. For example, the VP7 has been integrated into STMicrolectronics'
STV0397 semiconductor. The VP7 is based on NME's proprietary DSP architecture,
which allows flexibility via software microcode that is downloaded to the core
engine.
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REFERENCE DESIGN KITS -- NME currently supplies the following reference
design kits for its semiconductor products:
- The Media Hub MH2 reference design is a two-line, VoIP gateway based on
the Audacity-T2 processor. It supports two analog telephone interfaces, a
10/100 Mbps Ethernet port, and a simple LCD display.
- The IP phone reference design includes plastics, keypad, display, and
handset and is based on the Audacity-T2 processor.
NME's reference design kits are intended to serve as prototype system
products. The designs are intended to allow a customer to leverage NME's system
design expertise and accelerate its time to market with new products. Each
reference design is provided with schematics, bills of materials (BOMs),
documentation, embedded software, and a software development environment that
enables a customer to customize the software and add new features.
VIDEOCONFERENCING SEMICONDUCTORS -- NME's family of videoconferencing
semiconductors includes the VCP, LVP, VPIC, and VCPex. These semiconductors are
used in H.323, H.320, and H.324 videoconferencing applications including group
videoconferencing systems, personal computer (PC) videophone add-in boards,
consumer videophones, and video monitoring systems. These semiconductors are
based on NME's proprietary architecture, which combines on a single chip a
custom RISC microprocessor, a high performance DSP core, SRAM, and proprietary
software, which together perform the core processing functions required by LAN,
ISDN, and POTS-based video communication and other digital video applications.
HOSTED IPBX SOLUTIONS
The Company's subsidiary, Centile, is developing and marketing a hosted
iPBX, a software-driven telephony solution that allows network service providers
and PBX resellers to offer PBX functionality as a business communication service
over broadband IP networks. The following sections describe Centile's technology
and products more fully.
Technology
A business today requires an individual phone for each office worker,
typically dozens for small and medium sized enterprises (SMEs). Until recently,
there were two ways that businesses could obtain this type of phone service:
subscribe to Centrex services from their local telephone company or buy a PBX
system. In a Centrex service, the telephone company provides a telephone line
from its central office switch for each "extension" and associates all of the
lines with a central number assigned to the business. Centrex, however, scales
poorly for both regulatory and architectural reasons. It is expensive on a
per-line basis when compared to enterprise-owned PBXs, which typically deliver
additional functionality as well. In addition, Centrex services do not offer the
ability for easy integration with computer programs, require long lead times for
moves, adds, and changes, and are difficult to manage.
Rather than subscribe to individual telephone lines for each employee (as
with Centrex), most companies purchase a PBX system, a telephone switch that
allows dozens or hundreds of employees to share a few incoming and outgoing
telephone lines, allowing efficient usage of those lines. Traditional PBXs use
circuit-switched technology and must be installed on the enterprise premise
because every phone is connected to it by an individual cable. These systems are
expensive (from $20,000 to $200,000 or more, depending on the number of
extensions), difficult to manage, maintain, and use, and cannot be easily
integrated with data processing systems.
With the availability of broadband IP connectivity to businesses, however,
a third alternative has emerged: hosted iPBX services. In this model, the
service provider delivers PBX functionality over an IP connection, which reduces
the scaling problems by allowing many extensions to share a single connection.
This solution also offers many of the advantages of an enterprise-owned PBX and
further enables integration with enterprise data processing systems and support
of call centers, while eliminating the capital and maintenance investments
required for a PBX.
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TELEPHONY CALL MANAGEMENT SOFTWARE -- Centile's telephony call management
software (the iPBX server software, hosted iPBX, or iPBX), uses an IP network
for both its switching fabric and media connections, providing the call routing,
setup, and teardown necessary to establish a connection between two terminals on
an IP network. It also provides a variety of more complex PBX features such as
call transfers, web-based control and voice message retrieval, and conferencing.
The iPBX software runs on a cluster of carrier-grade server platforms that
are located in a data center. A cluster typically consists of both active and
backup servers. Each active server runs several copies or "instances" of the
iPBX software simultaneously. Each instance is dedicated to a particular phone
line for an individual user. The server cluster in the data center is linked to
customer sites with a dedicated broadband IP link such as a T1 line. On the
customer premise, media hubs or IP telephones are connected to the IP link via
an IP router and Ethernet hubs or switches. Media hubs connect standard analog
telephones and fax machines to the IP network.
To address scalability and reliability issues, Centile uses a modular and
distributed architecture for the iPBX system. In this architecture, a single
instance of the iPBX server software provides complete PBX functionality, but it
is designed to support approximately 100 extensions. Limiting the number of
extensions supported limits both the processing capacity and memory requirements
of the server platform, allowing less powerful, less expensive servers to be
used. Multiple iPBX instances can be run on each server and the system can be
scaled by adding more servers.
This modular approach has another advantage. By limiting the capacity and
therefore the size and processing requirements of the iPBX software, an instance
of the iPBX can be dedicated to a specific customer. Doing so allows each
instance to be customized for each customer by linking it to customer-specific
computer programs for call center automation or by selecting unique functions
for feature phone buttons.
Much of the flexibility of the iPBX is due to the use of abstraction layers
between the core iPBX engine and the devices with which it interfaces and which
it controls. To allow it to interface to a variety of different telephone sets,
PSTN gateways, and softswitches, the iPBX uses hardware drivers that support
various industry standard and proprietary call setup and teardown protocols.
Currently, the iPBX supports session initiation protocol (SIP), media gateway
control protocol (MGCP), H.323v2, and a variety of proprietary protocols.
To allow easy integration with computer programs (computer telephony
integration, or CTI), the iPBX was based on the ECTF C.001 specification for PBX
functionality and supports Sun Microsystems' Java Telephony Application Program
Interface (JTAPI) version 1.3 for telephony call control. The ECTF C.001
specification defines a consistent call control behavior for PBXs, making it
easier to develop computer programs that can control a PBX, and JTAPI provides
an industry standard series of function calls to allow computer programs to
control PBXs from more than one manufacturer. Computer programs interfaced to
the PBX might provide a graphical user interface to make it easier to transfer
calls or initiate conference calls, or they might connect a company's customer
relationship management software directly to the phone system, displaying
customer information on a computer screen when that customer calls for support.
Running each instance of the iPBX in its own Java Virtual Machine (Java VM)
offers a number of advantages. First, every instance of the iPBX is designed to
be completely insulated from every other instance so a failure in one should
never cause a failure in any other. In other operating environments, system
resources such as communication routines and database managers are frequently
shared between all of the programs that run on that machine. If one program
misuses a display driver, for example, all of the other programs running on that
machine may be affected. Because each Java VM provides all of these resources to
the program it hosts, this kind of inter-process interference should not occur.
A second advantage is security because each iPBX instance is separate from all
others. Its configuration data and call control logic are also separate. It is
much less likely that another user will inadvertently (or purposely)
mis-configure another customer's iPBX.
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The iPBX solution was designed to address the shortcomings of traditional
Centrex service offerings in a number of ways as described below.
- The use of an IP network allows the iPBX to scale relatively easily and
economically because subscribers can add additional extensions without
adding a new cable for each extension. Additional IP phones are plugged
into the existing LAN.
- The iPBX uses an IP network instead of a circuit-switched one so it can
be located in the service provider's data center which may be miles away
from the customer enterprise premise and connected to it by only a single
broadband IP link.
- The redundancies built into the system increase its reliability,
particularly when compared to enterprise owned PBXs. The Company also
offers a monitoring service, in partnership with its customers, via a
Network Operations Center (NOC) to minimize service outages and downtime
of the iPBX network.
Products
IPBX SERVER SOFTWARE -- Introduced in March 2000 and commercially released
for general availability in March 2001, the Centile iPBX server software runs on
a cluster of five Sun Microsystems Netra T1s to provide software PBX
functionality over IP networks. The iPBX software was designed specifically to
allow service providers to deliver hosted iPBX services to small and
medium-sized business customers. The Centile iPBX will allow service providers
to support up to eighty discrete iPBXs per cluster, each dedicated to an
individual customer, and up to five thousand total extensions.
The Netra cluster running the iPBX server software is located in the
service provider's data center. It is connected to the customer's premise using
any broadband IP connection, though deployments to date have generally utilized
a T1 connection. For telephone sets, customers can use media hubs to adapt
standard analog telephones to IP service or they can use IP phones. The iPBX
server software connects to the PSTN and the long-distance IP backbone through a
gateway.
Service providers control and configure the iPBX server software via a Web
interface, allowing the system administrator to manage the iPBX from any
location using any workstation with a browser. Centile also offers a Network
Operations Center (NOC) service (discussed below) to provide service
provisioning and network monitoring services. The administrator interface is
designed to provide control of phone number block assignments, dial plans,
service provisioning, DID assignments, iPBX status, bandwidth management, and
network topology. The iPBX supports external billing, voicemail, interactive
voice response, automatic call distribution, auto attendants, directory service,
unified messaging modules, and OSS (operation, service, and support)
integration.
MH4 MEDIA HUB -- Media hubs are customer premise equipment that adapt
conventional telephony equipment, such as analog telephones and fax machines,
for IP service. Centile's MH4 media hub product supports four analog lines.
Centile currently uses the Company's MH4 product, along with certain IP phones
and media hubs developed by third parties, in its hosted iPBX business
communication service deployments.
Each media hub supports as many simultaneous connections as it has analog
lines and multiple media hubs can be used in an IP telephony system to provide
as many lines as required. Because it uses a standard touch-tone telephone as
both its audio and user interface, media hub-based systems are both reliable and
cost-effective, especially when compared to proprietary digital PBX telephones.
MH4 media hubs support the MGCP IP telephony standard with Centile
extensions for auto-discovery and configuration. All media hubs deployed by
Centile incorporate FLASH memory for remote upgrade capability so that the
Centile iPBX server software can upgrade media hubs automatically via the
network as required.
IPBX USER INTERFACE SOFTWARE -- Centile has announced three user interface
applications for its hosted iPBX solution: Communication Center, Switchboard,
and Administrator. All of these applications are designed to harness the
graphical capabilities of personal computers and workstations to make the hosted
iPBX easy to use.
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The Centile Communications Center software with Call Announcer is designed
for the end users of the iPBX. It provides Caller ID, call transfers, conference
call setup, on-screen directories, contact management, and call logging. It also
lets users set up and control their voicemail, set forwarding numbers and
filters, and set up personal speed dial numbers.
The Centile Switchboard software (Switchboard) is the attendant interface
for the iPBX. Switchboard runs on a personal computer or workstation to allow
attendants to route incoming calls to an enterprise with a point-and-click
interface. Switchboard provides caller ID for multiple incoming calls, extension
status, two-click call transfers, corporate voice mailbox management, and
multi-attendant support. Its graphical interface minimizes training and improves
attendant productivity.
With the iPBX, customers control their own moves, adds, and changes using
the Centile Administrator (Administrator). To add additional lines, the customer
simply connects an additional media hub to the IP network. The Centile Auto
Discovery mechanism automatically configures the media hub. The customer then
uses Administrator to assign extension numbers, associate user names, and create
a voicemail account for each line. Administrator also allows the customer to
define hunt groups, set user permissions, define phone button functions, and set
voicemail parameters, all with a point-and-click interface.
NETWORK OPERATIONS CENTER (NOC) -- Centile maintains a 24x7 Network
Operations Center (NOC) staffed by personnel trained in the use of monitoring,
debugging, and deploying software associated with the hosted iPBX business
communication service. The NOC monitors customer deployments, responds to
service and add/move/change requests, and assists customers with any reported
service problems. The NOC personnel training and operating procedures are
documented and packaged in a form which allows Centile to provide service
providers with the capability to create and deploy their own NOC facilities.
SERVICE CREATION SOFTWARE
Technology and Products
SERVICE CREATION ENVIRONMENT -- The Company is developing a set of software
applications that enable telecommunication equipment providers to specify,
create, and deploy next-generation VoIP services. Historically,
telecommunication equipment providers offered their customers fixed menus of
services and applications that could be run in conjunction with the
telecommunication network. The providers offered rigid sets of available
applications that were slow to change and were not customizable to meet the
needs of different customers.
With the convergence of voice and data networks, telecommunication
providers now have the building blocks to build rich sets of custom-tailored
voice and data services. Based upon technology acquired from UCForce in June
2000, the Company has been developing a software tool that is designed to enable
these new services and applications to be quickly created, customized, modified,
deployed, and delivered while maintaining the robust service delivery paradigm
of the legacy switched network. This tool provides users with an easy to use
graphical user environment for creating a specification of the logical flow for
a range of telecommunication service applications, such as voicemail, unified
messaging, automated call centers, and other call processing applications. The
critical requirements of this tool are: to de-couple service creation and
delivery from the physical network or set of devices that the service is running
on; to allow open, flexible, and fast service creation (even by the end-user of
the service, in some instances); and to provide robust service delivery.
The Company's product offering, which bundles this tool and other related
software development applications, is called the Service Creation Environment
(SCE). The core software components of the SCE are written in Java. Java
provides a number of important advantages over older computer languages, such as
C and C++. For example, all Java programs run in a Java VM, which translates
Java code to a specific operating environment, such as Windows or Sun Solaris.
This allows the SCE to be easily run on a number of different hardware
platforms, including Windows-based machines, Solaris platforms, and Linux
machines. The Java VM also provides memory management that eliminates frequent
sources of problems in other
8
11
development environments including pointer arithmetic and automatic garbage
collection. Moreover, Java removes coding ambiguities that are a common problem
with C and C++.
As with the hosted iPBX, the SCE uses JTAPI for its system telephony
interface design. While JTAPI is a standard interface, different system
implementations of the JTAPI protocol can make it extremely difficult to port a
JTAPI application to a new platform. The Company's software takes advantage of
its robust implementation of JTAPI calls and usage to maximize the SCE's
compatibility with different computing platforms.
The Company is currently developing an enhanced version of the SCE for
executing service logic applications in high volume call processing
environments.
UNIFIED MESSAGING -- The Company's unified messaging (UM) software is a
pre-packaged application, or service, that was created with the SCE. The UM
software was designed to allow a user to receive and retrieve messages of
different data types from a single telephony access point. For example, a user
is assigned a telephone number that can be used to leave or retrieve voice
messages, FAX messages or e-mail (FAX and e-mail messages are sent through a
text-to-speech engine and read back to the user on the phone). Similarly, a user
could access voice messages from any network-enabled personal computer or
receive FAX messages in electronic form as e-mail. The Company's UM software is
not currently deployed in a commercial setting, and future UM development
efforts are dependent on deployments of the Company's SCE product.
CUSTOMERS AND MARKETING
SEMICONDUCTORS AND EMBEDDED SOFTWARE
CUSTOMERS -- NME sells its IP telephony semiconductors, embedded software,
and reference designs to OEMs of VoIP products, such as BATM, CIDCO, D-Link,
Ericsson, and WellTech. NME has also licensed portions of its semiconductor
technology and embedded VoIP software to Alcatel Microelectronics and
STMicroelectronics.
NME sells its LVP semiconductors, related software, and reference board
designs to OEMs of POTS video communication systems for the consumer and video
monitoring market, such as Interlogix, Inc., Kyushu Matsushita Electric Co.,
Ltd., (KME), Leadtek Research, Inc., and Samsung. NME is selling its VCP and
VCPex semiconductors, related software, and reference designs primarily to OEMs
of ISDN and LAN office videoconferencing systems, including Mitsubishi
Electronics, PictureTel Corporation, Sony Electronics, Inc., VCON
Telecommunications Ltd., and VTEL Corporation.
SALES AND MARKETING -- NME markets its semiconductor, embedded software,
and reference design products through its own direct sales force, third-party
sales representatives, and distributors. NME supports its domestic and
international direct sales efforts from its headquarters in Santa Clara,
California and a European office in Marlow, United Kingdom. NME's sales and
marketing personnel typically provide support to its OEM and distributor
customers through its application engineering team and periodic training
sessions.
COMPETITION -- NME competes with both manufacturers of digital signal
processing semiconductors and software products developed for the OEM VoIP
marketplace. NME also competes with manufacturers of videoconferencing
semiconductors and related firmware. The markets for NME's products are
characterized by intense competition, declining average selling prices, and
rapid technological change. The principal competitive factors in the market for
IP telephony and videoconferencing semiconductors and embedded software include
product definition, product design, system integration, chip size, code size,
functionality, time-to-market, adherence to industry standards, price, and
reliability. NME has a number of competitors in this market including: Agere
Systems, Analog Devices, Inc., AudioCodes Ltd., Broadcom Corporation, Conexant
Systems, Inc., DSP Group, Mitel Semiconductor, Motorola, Inc., Radvision Ltd.,
Texas Instruments/Telogy Networks, Inc., TriMedia Technologies, Inc. (a Philips
Electronics and Sony Corporation joint venture), and Winbond Electronics.
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HOSTED IPBX SOLUTIONS
CUSTOMERS -- During fiscal 2000, the Company announced its iPBX server
software product and a limited external deployment of its hosted iPBX services
through Dialink, a competitive local exchange carrier (CLEC) based in the San
Francisco Bay Area. In addition to the Dialink customer trial, the Company is in
laboratory trial testing with several other service providers.
In fiscal 2001, the Company decided that the long trials and time-to-market
constraints of the CLEC and service provider market, as well as the decreasing
availability of cash to certain CLECs in the North American market, required
that the Company provide a hosted business communication service offering to PBX
resellers in addition to the existing service provider offering. In March 2001,
the Company formed Centile to conduct the operations of the hosted iPBX business
and announced a reseller agreement with Millennia Telecom. Centile is still
actively marketing the product to service providers in Europe. In April 2001
Centile announced a licensing agreement with Telecom Partners and in May 2001
announced a licensing agreement with Tele1 Europe Holding AB.
SALES AND MARKETING -- Centile markets the hosted iPBX software product
through a direct sales force. In addition, Centile has established a
relationship with Exodus Communications, a hosted service provider partner, and
intends to establish relationships with PBX and other system integrators that
can serve as resellers. The sales force operates primarily from the Company's
headquarters in Santa Clara, California.
COMPETITION -- Centile currently competes with suppliers of traditional
PBXs, Centrex equipment, and newer generation IP-based PBX or Centrex solutions
that seek to sell such products to telecommunication service providers or to the
small and medium-size enterprise (SME) marketplace. The main competition
includes Avaya, Cisco, Commworks Corporation, Lucent, Mitel, Nortel Networks,
Sylantro Systems, VocalData, Inc., VocalTec Communications, and several other
providers of traditional and newer generation IP-based solutions, such as
Broadsoft, Inc. (which is being acquired by Unisphere Networks), IP Centrex,
Shoreline Communications, Sphere Communications, Tundo Corporation and Vertical
Networks.
As an IP-based solution, the hosted iPBX product competes by leveraging the
innate efficiencies of IP architectures and combining those efficiencies with
certain required features from competitive legacy products. The principal
competitive factors in the market for hosted iPBX solutions include product
feature parity, interface design, product reliability, time-to-market, adherence
to standards, price, functionality, and IP network delivery/design. The Company
believes that the market for iPBX solutions is currently in the initial adoption
phase and that growth of the market will be driven primarily by three factors:
the ability of iPBX products to meet the advanced feature requirements of end
customers; the lower costs of IP-based solutions; and a general trend toward the
replacement of circuit-switched networks with packet-switched ones.
SERVICE CREATION SOFTWARE
CUSTOMERS -- In May 2001, the Company announced the first customer license
of its SCE to Lucent. The SCE will be used in Lucent's enhanced Service
Authoring Environment (eSAE), an authoring environment for creating intelligent
networking applications for both voice and data networks within Lucent's
PacketIN intelligent network service control point. The Company has established
a royalty-bearing licensing agreement with Lucent whereby Lucent will sell the
SCE under Lucent's eSAE branding. Under a maintenance clause in the agreement,
the Company may also provide support, training, and professional services
directly to Lucent's customers, at Lucent's option.
SALES AND MARKETING -- As a result of the cessation of the Company's
Canadian operations in the fourth quarter of fiscal 2001, sales and marketing
efforts related to the SCE and related products, including UM, have been
drastically reduced. The Company does not currently have any in-house or third
party sales efforts dedicated to marketing its SCE and related products to
customers other than Lucent nor does the Company presently have plans to
increase such efforts. Sales and marketing activities in the foreseeable future
may include demonstrating the SCE product to other potential OEM customers if
opportunities arise and providing sales literature, demonstration platforms, and
pre-sales support in pursuing such opportunities.
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COMPETITION -- The Company competes with other providers of enhanced
service platforms, applications, and service creation solutions for
next-generation communication networks. The applications generated by the SCE
also compete with suppliers of traditional telecommunication applications
software that seek to sell such products to telecommunication equipment
manufacturers and service providers. The main competitors for the Company's SCE
product line are Alcatel, Dynamicsoft, Inc., LongBoard, Inc., Nortel Networks,
Pactolus Communications, Pagoo, Sylantro Systems, Tekelec, Telcordia, Telsis,
and Ubiquity Software. This market is characterized by rapid technological
change, intense competition, and first-mover advantage. Principal competitive
factors in the market for the Company's SCE product include product feature
parity, interface design, product reliability, performance, time-to-market,
adherence to standards, price, functionality, and IP network delivery/design.
MANUFACTURING
NME outsources the manufacturing of its semiconductors to independent
foundries. NME's primary semiconductor manufacturer is Taiwan Semiconductor
Manufacturing Corporation (TSMC). NME also relies on various independent third
party companies for packaging and testing of its semiconductors. NME does not
have long-term purchase agreements with its subcontract manufacturers or its
component suppliers.
RESEARCH AND DEVELOPMENT
Research and development expenses in the fiscal years ended March 31, 2001,
2000, and 1999 were $18.8 million, $11.9 million, and $9.9 million,
respectively. The development of new products and the enhancement of existing
products by the Company and its subsidiaries are essential to their success.
The Company's current and future research and development efforts relate
primarily to VoIP semiconductors and embedded software, hosted iPBX systems, and
service creation and execution technologies. Areas of emphasis will include:
enhanced versions of its Audacity-T2 semiconductor architecture to provide
higher performance, enhanced functionality, and further integration of certain
essential system functions and interfaces; enhanced versions of its hosted iPBX
business communication service to include additional call control features,
system management capabilities, additional protocol and telephony device
support, and new graphical user interface and web-based applications; and
enhanced versions of the SCE to offer additional editor features and a
performance-enhanced version of the service logic execution environment,
specifically tailored for high volume call switching environments. Future
developments may also focus on emerging audio and video telephony standards and
protocols, quality and performance enhancements to multimedia compression
algorithms, and additional features supporting all of the Company's products.
LICENSING AND DEVELOPMENT ARRANGEMENTS
The Company has entered into licensing and development arrangements with
its customers to promote the design, development, manufacture, and sale of the
Company's products. In order to encourage the use of its semiconductors, NME has
licensed portions of its systems technology and software object code for its
semiconductors to virtually all of its semiconductor customers. Moreover, many
of NME's OEM customers have licensed portions of the source code to its software
for its semiconductors. NME intends to continue to license its semiconductor,
software, and systems technology to other companies, many of which are current
or potential competitors. Such arrangements may enable these companies to use
NME's technology to produce products that compete with the Company's IP
telephony and video products.
NME has also licensed the right to manufacture certain of its
videoconferencing and IP telephony semiconductor products, subject to payment of
royalties, to several original equipment manufacturers (OEMs). Of these OEM
licensees, only Alcatel Microelectronics, ESS Technology, Inc. (ESS), and
STMicroelectronics may sell semiconductors based on the licensed technology to
third parties, while other licensees are limited to sales of such semiconductors
as part of multimedia communication systems or sub-systems. The obligation of
ESS to pay royalties to the Company with regard to the sale of semiconductors
based on the licensed technology expired in October 2000.
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In addition, Netergy has licensed source code for its SCE product to
Lucent. Under the agreement, Lucent has licensed the technology for use in its
Enhanced Service Authoring Environment (eSAE), which enables carriers and
application developers to design innovative new services for converged voice and
data networks. Netergy may continue to license its SCE source code to other
companies. Such arrangements may enable these companies to use the technology to
produce products that compete with Netergy's SCE and related products.
The Company expects to continue licensing its technology to others, many of
whom may be located outside of the United States. In addition to licensing its
technology to others, the Company from time to time will take a license to
technology owned by third parties and currently relies upon certain technology,
including hardware and software, licensed from third parties.
EMPLOYEES
As of March 31, 2001, the Company employed 156 persons, including 8 in
manufacturing operations, 86 in research and development, 35 in sales and
marketing, and 27 in general and administrative capacities. None of the
Company's employees are represented by a labor union or are subject to a
collective bargaining arrangement. The Company believes that relations with
employees are good.
ITEM 2. PROPERTIES
The Company's principal operations are located in an approximately 45,000
square foot facility in Santa Clara, California that is leased through May 2003.
Design, limited manufacturing, research and development, marketing, and
administrative activities are performed in this facility.
The Company also leases facilities for its sales office in Marlow, United
Kingdom, and for its research and development operation in Sophia Antipolis,
France. In addition, the Company has a lease for approximately 6,000 square feet
of vacant office space in Hull, Canada that it is actively seeking to sublet.
The Company believes that its existing facilities are adequate to meet its
current and foreseeable future needs. For additional information regarding the
Company's obligations under leases see Note 10 to the Consolidated Financial
Statements contained in Part II, Item 8.
ITEM 3. LEGAL PROCEEDINGS
On April 6, 2001, the Company, along with Sun Microsystems, Inc., Netscape
Communications Canada Inc., Burntsand Inc., and Intraware Canada Inc., was sued
by Milinx Business Services, Inc. and Milinx Business Group Inc. (collectively,
"Milinx") in the Supreme Court of British Columbia, Canada (the "Court"). Milinx
has alleged that the Company failed to perform certain contractual obligations
and knowingly misrepresented the capabilities of its products. The lawsuit seeks
general, special, and aggravated damages totaling in excess of Canadian $65
million plus interest, costs, and any other relief which the Court may choose to
provide. Management believes that the Company has valid defenses against the
claims alleged by Milinx and intends to defend this lawsuit vigorously. However,
due to the nature of litigation and because the lawsuit is in the very early,
pre-discovery stages, the Company cannot determine the possible loss, if any,
that may ultimately be incurred either in the context of a trial or a negotiated
settlement. If the Company does not prevail in any such litigation, its
operating results and financial condition could be adversely impacted.
The Company is involved in various other legal claims and litigation that
have arisen in the normal course of the Company's operations. While the results
of such claims and litigation cannot be predicted with certainty, the Company
believes that the final outcome of such matters will not have a significant
adverse effect on the Company's financial position or results of operations.
However, should the Company not prevail in any such litigation, its operating
results and financial condition could be adversely impacted.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this Report.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
The Company effected its initial public offering on July 2, 1997 under the
name 8x8, Inc. From that date through April 3, 2000, the Company's common stock
was traded on the NASDAQ National Market (the NASDAQ) under the symbol "EGHT."
Starting April 4, 2000 the Company's common stock has been traded on the NASDAQ
under the symbol "NTRG." The Company has never paid cash dividends on its common
stock and has no present plans to do so. As of May 4, 2001, there were 272
holders of record of the Company's common stock. The following table sets forth
the range of high and low closing prices for each period indicated:
PERIOD HIGH LOW
------ ------ -----
Fiscal 2001
First Quarter............................................. $29.63 $7.67
Second Quarter............................................ $12.94 $6.63
Third Quarter............................................. $ 9.06 $1.50
Fourth Quarter............................................ $ 4.72 $0.78
Fiscal 2000
First Quarter............................................. $ 6.25 $3.94
Second Quarter............................................ $ 5.50 $2.75
Third Quarter............................................. $ 5.83 $3.94
Fourth Quarter............................................ $34.63 $5.63
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED MARCH 31(1)
-------------------------------------------------------
2001(2)(5) 2000(3)(5) 1999(4) 1998 1997
---------- ---------- -------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total revenues.............................. $ 18,228 $ 25,384 $ 31,682 $49,776 $ 19,146
Net income (loss)........................... $(74,399) $(24,848) $(19,224) $ 3,727 $(13,613)
Net income (loss) per share:
Basic..................................... $ (2.99) $ (1.38) $ (1.28) $ 0.31 $ (2.56)
Diluted................................... $ (2.99) $ (1.38) $ (1.28) $ 0.25 $ (2.56)
Total assets................................ $ 39,145 $ 59,983 $ 28,709 $46,429 $ 12,727
Convertible subordinated debentures......... $ 6,238 $ 5,498 $ -- $ -- $ --
- ---------------
(1) Fiscal 2001 was a 52 week and 2 day fiscal year. Fiscal year 2000 was a
53-week fiscal year, while fiscal 1999, 1998, and 1997 were 52-week fiscal
years.
(2) Net loss and net loss per share include a restructuring charge of $33.3
million, an in-process research and development charge of $4.6 million, and
a $1.1 million charge for the cumulative effect of a change in accounting
principle.
(3) Net loss and net loss per share include a $6.4 million charge for a discount
on the issuance of common stock and an in-process research and development
charge of $10.1 million.
(4) Net loss and net loss per share include a $5.7 million charge associated
with the write off of ViaTV consumer videophone inventories.
(5) Convertible subordinated debentures are presented net of the related debt
discount, which is being amortized over the three-year term of the
debentures. The face value of the debentures is $7.5 million.
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ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements within the meaning of Section 27A
of the Securities Act and Section 21E of the Exchange Act, including, but not
limited to, those specifically identified as such, that involve risks and
uncertainties. The statements contained in this Report on Form 10-K (the Report)
that are not purely historical are forward looking statements, including,
without limitation, statements regarding our expectations, beliefs, estimates,
intentions or strategies regarding the future, including statements regarding
working capital and capital expenditure requirements, efforts to raise
additional financing, the acquisition or investment in other businesses and
products, commitment of resources, and reduction in operating costs including
the possible sale or cessation of certain business lines and the possible
reduction of personnel and suspension of salary increases and capital
expenditures. All forward-looking statements included in this Report are based
on information available to us on the date hereof, and we assume no obligation
to update any such forward-looking statements. You should not place undue
reliance on these forward-looking statements. Actual results could differ
materially from those anticipated in these forward-looking statements as a
result of a number of factors, including, but not limited to, risks faced by us
as described in this Report, including those set forth under the section
entitled "Factors that May Affect Future Results" in Item 1, and the other
documents we file with the Securities and Exchange Commission (SEC) including
our most recent reports on Form 8-K.
OVERVIEW
Netergy Networks, Inc. and its subsidiaries (collectively, We or Netergy)
develop and market telecommunication technology for Internet Protocol (IP)
telephony and video applications. We have three product lines: voice and video
semiconductors and related software, hosted Internet Private Branch Exchange
(iPBX) solutions, and Voice-over-IP (VoIP) service creation software.
During the fiscal year ended March 31, 2001, we formed two subsidiaries,
Netergy Microelectronics, Inc. (NME) and Centile, Inc. (Centile) and reorganized
our operations more clearly along our three product lines. NME provides voice
and video semiconductors and related communication software to original
equipment manufacturers (OEMs) of telephones, terminal adapters, and other edge
devices and to other semiconductor companies. NME's technologies are used to
make IP telephones and to voice-enable cable and digital subscriber line (DSL)
modems, wireless devices, and other broadband technologies. Centile develops and
markets hosted iPBX solutions that allow service providers to offer private
branch exchange (PBX) functionality to small and medium-sized businesses over
broadband networks. We are also developing a third product line, a VoIP service
creation environment (SCE), at the parent company level. This product is
designed for use by telecommunication equipment manufacturers and service
providers.
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RESULTS OF OPERATIONS
The following table sets forth consolidated statement of operations data
for each of the years ended March 31, 2001, 2000, and 1999, as well as the
percentage of our total revenues represented by each item. Cost of product
revenues is presented as a percentage of product revenues and cost of license
and other revenues is presented as a percentage of license and other revenues.
You should read this information in conjunction with our Consolidated Financial
Statements and related notes included elsewhere in this Report:
YEAR ENDED MARCH 31,
--------------------------------------------------
2001 2000 1999
-------------- -------------- --------------
($ IN MILLIONS)
Product revenues......................... $ 12.8 70% $ 20.8 82% $ 26.2 83%
License and other revenues............... 5.4 30% 4.6 18% 5.5 17%
------ ---- ------ ---- ------ ----
Total revenues................. 18.2 100% 25.4 100% 31.7 100%
------ ---- ------ ---- ------ ----
Cost of product revenues................. 5.2 41% 8.5 41% 24.2 92%
Cost of license and other revenues....... 1.8 33% 0.1 3% 0.1 2%
------ ---- ------ ---- ------ ----
Total cost of revenues......... 7.0 38% 8.6 34% 24.3 77%
------ ---- ------ ---- ------ ----
Gross profit................... 11.2 62% 16.8 66% 7.4 23%
------ ---- ------ ---- ------ ----
Operating expenses:
Research and development............... 18.7 104% 11.9 47% 9.9 31%
Selling, general and administrative.... 18.1 99% 21.3 84% 17.7 56%
In-process research and development.... 4.6 25% 10.1 40% -- --%
Restructuring charge................... 33.3 183% -- --% -- --%
Amortization of intangibles............ 11.0 60% 0.6 2% -- --%
------ ---- ------ ---- ------ ----
Total operating expenses....... 85.7 471% 43.9 173% 27.6 87%
------ ---- ------ ---- ------ ----
Loss from operations..................... (74.5) (409)% (27.1) (107)% (20.2) (64)%
Other income, net........................ 2.6 14% 2.8 11% 1.0 3%
Interest expense......................... (1.4) (8)% (0.4) 2% -- --%
------ ---- ------ ---- ------ ----
Loss before provision for income taxes... (73.3) (403)% (24.7) (97)% (19.2) (61)%
Provision for income taxes............... -- --% 0.1 1% -- --%
------ ---- ------ ---- ------ ----
Net loss before cumulative effect of
change in accounting principle......... (73.3) (403)% (24.8) (98)% (19.2) (61)%
Cumulative effect of change in accounting
principle.............................. (1.1) (6)% -- --% -- --%
------ ---- ------ ---- ------ ----
Net loss................................. $(74.4) (409)% $(24.8) (98)% $(19.2) (61)%
====== ==== ====== ==== ====== ====
Revenues
The following table illustrates net revenues by groupings of similar
products (in thousands):
YEAR ENDED MARCH 31,
-----------------------------
2001 2000 1999
------- ------- -------
Videoconferencing semiconductors............................ $ 9,478 $11,323 $10,302
IP telephony semiconductors................................. 1,878 37 --
Consumer videophone systems................................. 105 3,000 12,935
Video monitoring systems.................................... 915 6,006 2,952
Media hub systems........................................... 432 451 --
------- ------- -------
Product revenues.................................. 12,808 20,817 26,189
------- ------- -------
Videoconferencing licenses and royalties.................... 3,237 4,318 4,248
IP telephony licenses and royalties......................... 825 179 --
Nonrecurring engineering fees............................... -- -- 1,245
Hosted iPBX licenses........................................ 198 70 --
Professional services....................................... 1,160 -- --
------- ------- -------
License and other revenues........................ 5,420 4,567 5,493
------- ------- -------
Total revenues.................................... $18,228 $25,384 $31,682
======= ======= =======
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Product revenues were $12.8 million in fiscal 2001, a decrease of $8.0
million from the $20.8 million reported in fiscal 2000. The decrease in product
revenues in fiscal 2001 was primarily due to decreases in sales of video
monitoring and consumer videophone systems, resulting from our exit from these
businesses, and a decrease in average selling prices for our videoconferencing
semiconductors. These decreases were partially offset by an increase in IP
telephony semiconductor revenues resulting from the commercial release of our
Audacity-T2 product in fiscal 2001. Product revenues were $20.8 million in
fiscal 2000, a decrease of $5.4 million from the $26.2 million reported in
fiscal 1999. The decrease in product revenues in fiscal 2000 compared to fiscal
1999 was primarily due to a significant decrease in unit shipments of our
consumer videophone systems and average selling prices (ASPs) realized on those
shipments. This decrease was partially offset by increases in unit shipments of
our videoconferencing semiconductor and video monitoring system products.
License and other revenues consist primarily of technology licenses,
including royalties earned pursuant to such licenses, and nonrecurring
engineering fees for services performed by us for our customers. License and
other revenues for fiscal 2001 also included service revenues resulting from the
integration of U/Force's professional services organization after the
acquisition of U/Force in June 2000. License and other revenues increased
$853,000, from $4.6 million in fiscal 2000 to $5.4 million in fiscal 2001, due
primarily to U/Force professional service revenues of $1.2 million, offset by a
decrease in royalties earned under a license agreement with ESS Technology, Inc.
for certain of our video compression technology, which expired in October 2000.
License and other revenues were $4.6 million in fiscal 2000, a decrease of
$926,000 from the $5.5 million reported in fiscal 1999, due primarily to a
decrease in nonrecurring engineering fees.
Revenues from our ten largest customers in the fiscal years ended March 31,
2001, 2000, and 1999 accounted for approximately 48%, 35%, and 40%,
respectively, of our total revenues. During the fiscal years ended March 31,
2001, 2000, and 1999, no customer accounted for 10% or more of total revenues.
Sales to customers outside the United States represented 63%, 47%, and 43%
of total revenues in the fiscal years ended March 31, 2001, 2000, and 1999,
respectively. Specifically, sales to the Asia Pacific region represented 31%,
24%, and 26% of our total revenues for the fiscal years ended March 31, 2001,
2000, and 1999, respectively. Our sales to Europe represented 32%, 23%, and 17%
of total revenues for the fiscal years ended March 31, 2001, 2000, and 1999,
respectively.
Cost of Revenues and Gross Profit
The cost of product revenues consists of costs associated with components,
semiconductor wafer fabrication, system and semiconductor assembly and testing
performed by third-party vendors, and direct and indirect costs associated with
purchasing, scheduling, and quality assurance. Gross profit from product
revenues was $7.6 million, $12.3 million, and $2.0 million for the fiscal years
ended March 31, 2001, 2000, and 1999, respectively. Product gross margin was 59%
for fiscal 2001 and fiscal 2000, compared to 8% in fiscal 1999. The $4.7 million
decrease in gross profit from fiscal 2000 to fiscal 2001 is due primarily to a
significant decrease in sales of our video monitoring and consumer videophone
products due to our exit from those businesses. Gross profit in fiscal 2001 was
also impacted by lower average selling prices (ASPs) realized on sales of our
videoconferencing semiconductors, offset by a significant increase in IP
telephony semiconductor sales. The significant increase in product gross profit
in fiscal 2000 compared to fiscal 1999 was due to an increase in higher margin
videoconferencing semiconductor and video monitoring system revenues and due to
higher gross margins realized on sales of our ViaTV products. In addition,
fiscal 1999 gross profit and margins were significantly impacted by a $5.7
million charge associated with the write-off of ViaTV product inventory due to
our decision to cease production of the ViaTV product line and withdraw from our
distribution channels.
Gross profit from license and other revenues, substantially all of which
were nonrecurring, was $3.7 million, $4.5 million, and $5.4 million in fiscal
2001, 2000, and 1999, respectively. Associated gross margins were 67%, 97%, and
98% in fiscal 2001, 2000, and 1999. The significant decrease in gross margin
from fiscal 2000 to fiscal 2001 was due to reduced margins associated with our
professional service revenues in fiscal 2001. This was a result of lower than
expected utilization of our professional services resources and the
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elimination of the professional services organization as part of the
restructuring of our Canadian operations in the fourth quarter of fiscal 2001.
Research and Development Expenses
Research and development expenses consist primarily of personnel, system
prototype design and fabrication, mask, prototype wafer, and equipment costs
necessary for us to conduct our development efforts. Research and development
costs, including software development costs, are expensed as incurred. Research
and development expenses were $18.7 million, $11.9 million, and $9.9 million for
fiscal 2001, 2000, and 1999, respectively. Higher research and development
expenses during fiscal 2001 as compared to fiscal 2000 were due primarily to
increases in personnel, resulting from the acquisition of U/Force and increases
in hosted iPBX development efforts, higher consulting expenses associated with
the development of a graphical user interface for the hosted iPBX product,
higher depreciation and maintenance expenses as a result of additional lab
equipment and computer aided design tools, and increased stock compensation
charges of approximately $325,000 related to stock option bonus programs. Higher
research and development expenses during fiscal 2000 as compared to fiscal 1999
were due primarily to increased spending related to hosted iPBX system software
development. Significant expenses were also incurred in fiscal 2000 related to
development efforts associated with the Audacity-T2 processor and media hub
products.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses consist primarily of
personnel and related overhead costs for sales, marketing, finance, human
resources, and general management. Such costs also include advertising, sales
commissions, trade show, and other marketing and promotional expenses. Selling,
general, and administrative expenses were $18.1 million, $21.3 million, and
$17.7 million in fiscal 2001, 2000, and 1999, respectively. The decrease in
selling, general, and administrative expenses during the year ended March 31,
2001 as compared to the comparable period in the prior year is due primarily to
a one-time $6.4 million charge related to the sale of 3.7 million shares of our
common stock to STMicroelectronics that we recorded in the fourth quarter of
fiscal 2000. The charge reflected the discount from the fair market value of our
common stock on the date of the related agreement. The decrease also reflects
lower headcount and other costs required to support ViaTV and video monitoring
sales, promotion, and support activities due to our exit from the consumer
videophone and video monitoring businesses. These decreases were substantially
offset by increased expenses associated with the addition of the U/Force sales,
marketing, finance, and corporate organizations, costs incurred related to our
name change, and increased stock compensation charges. The increase in expenses
in fiscal 2000 compared to fiscal 1999 was primarily the result of the $6.4
million charge discussed above. This increase was offset by lower costs
associated with the marketing, advertising, and promotion of the ViaTV product
line and lower headcount required to support these activities as we exited the
consumer videophone business.
In-Process Research and Development and Amortization of Intangibles
We incurred in-process research and development charges of $10.1 million in
the first quarter of fiscal 2000 related to the acquisition of Odisei S.A.
(Odisei), and $4.6 million in the second quarter of fiscal 2001 related to the
acquisition of U/Force, Inc. (U/Force). A discussion of these acquisitions
follows below.
U/Force, Inc.
The Company's consolidated financial statements reflect the acquisition of
all of the outstanding stock of U/Force, Inc. on June 30, 2000 for a total
purchase price of $46.8 million. U/Force, based in Montreal, Canada, was a
developer of IP-based software applications and a provider of professional
services. U/Force was also developing a Java-based service creation environment
(SCE) that is designed to allow telecommunication service providers to develop,
deploy, and manage telephony applications and services to their customers. The
purchase price was comprised of Netergy common stock with a fair value of
approximately $38.0 million comprised of: (i) 1,447,523 shares issued at closing
of the acquisition, and (ii) 2,107,780 shares to be issued upon the exchange or
redemption of the exchangeable shares (the Exchangeable Shares) of Canadian
entities
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held by former employee shareholders or indirect owners of U/Force stock. The
Exchangeable Shares held by U/Force employees are subject to certain
restrictions, including our right to repurchase the Exchangeable Shares if an
employee departs prior to vesting. In addition, we also agreed to issue one
share of preferred stock (the Special Voting Share) that provides holders of
Exchangeable Shares with voting rights that are equivalent to the shares of
common stock into which their shares are convertible. We also assumed
outstanding stock options to purchase 1,023,898 shares of U/Force common stock
for which the Black-Scholes pricing model value of approximately $6.6 million
was included in the purchase price. Direct transaction costs related to the
merger were approximately $747,000.
The purchase price was allocated to tangible assets acquired and
liabilities assumed based on the book value of U/Force's assets and liabilities,
which we believe approximated their fair value. In addition, we engaged an
independent appraiser to value the intangible assets, including amounts
allocated to U/Force's in-process research and development. The in-process
research and development related to U/Force's initial products, the SCE and a
unified messaging application, for which technological feasibility had not been
established and the technology had no alternative future use. The estimated
percentage complete for the unified messaging and SCE products was approximately
44% and 34%, respectively, at June 30, 2000. The fair value of the in-process
technology was based on a discounted cash flow model, similar to the traditional
"Income Approach," which discounts expected future cash flows to present value,
net of tax. In developing cash flow projections, revenues were forecasted based
on relevant factors, including estimated aggregate revenue growth rates for the
business as a whole, characteristics of the potential market for the technology,
and the anticipated life of the technology. Projected annual revenues for the
in-process research and development projects were assumed to ramp up initially
and decline significantly at the end of the in-process technology's economic
life. Operating expenses and resulting profit margins were forecasted based on
the characteristics and cash flow generating potential of the acquired
in-process technologies. Risks that were considered as part of the analysis
included the scope of the efforts necessary to achieve technological
feasibility, rapidly changing customer markets, and significant competitive
threats from numerous companies. We also considered the risk that if we failed
to bring the products to market in a timely manner, it could adversely affect
sales and profitability of the combined company in the future. The resulting
estimated net cash flows were discounted at a rate of 25%. This discount rate
was based on the estimated cost of capital plus an additional discount for the
increased risk associated with in-process technology. Based on the independent
appraisal, the value of the acquired U/Force in-process research and
development, which was expensed in the second quarter of fiscal 2001,
approximated $4.6 million. The excess of the purchase price over the net
tangible and intangible assets acquired and liabilities assumed was allocated to
goodwill. Amounts allocated to goodwill, the value of an assumed distribution
agreement, and workforce were being amortized on a straight-line basis over
three, three, and two years, respectively. The allocation of the purchase price
was as follows (in thousands):
In-process research and development........................ $ 4,563
Distribution agreement..................................... 1,053
Workforce.................................................. 1,182
U/Force net tangible assets................................ 1,801
Goodwill................................................... 38,236
-------
$46,835
=======
Our consolidated financial statements include the results of the operations
of U/Force from the date of the acquisition, June 30, 2000, the beginning of our
second quarter of fiscal 2001.
Odisei S.A.
In May 1999, we acquired Odisei, a privately held, development stage
company based in Sophia Antipolis, France, that was developing software for
managing voice-over IP networks. The consolidated financial statements reflect
the acquisition of Odisei on May 24, 1999 for approximately 2,868,000 shares of
Netergy's common stock and approximately 121,000 of contingent shares, which
were subsequently issued to Odisei employee shareholders in March 2000.
Approximately 30,000 of the shares issued to Odisei employees
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are subject to repurchase as of March 31, 2001 if the employee departs prior to
vesting. The purchase price was approximately $13.6 million, which includes
approximately $295,000 of acquisition-related costs. The purchase price was
allocated to tangible assets acquired and liabilities assumed based on the book
value of Odisei's current assets and liabilities, which we believed approximated
their fair value. In addition, we engaged an independent appraiser to value the
intangible assets, including amounts allocated to Odisei's in-process research
and development. The in-process research and development related to Odisei's
initial product for which technological feasibility had not been established and
was estimated to be approximately 60% complete. The fair value of the in-process
technology was based on a discounted cash flow model, which discounted expected
future cash flows to present value, net of tax. In developing cash flow
projections, revenues were forecasted based on relevant factors, including
estimated aggregate revenue growth rates for the business as a whole,
characteristics of the potential market for the technology, and the anticipated
life of the technology. Projected annual revenues for the in-process research
and development projects were assumed to ramp up initially and decline
significantly at the end of the in-process technology's economic life. Operating
expenses and resulting profit margins were forecasted based on the
characteristics and estimated cash flow generating potential of the acquired
in-process technology. Associated risks include the inherent difficulties and
uncertainties in completing the project and thereby achieving technological
feasibility, and risks related to the impact of potential changes in market
conditions and technology. The resulting estimated net cash flows were
discounted at a rate of 27%. This discount rate was based on the estimated cost
of capital plus an additional discount for the increased risk associated with
in-process technology. Based on the independent appraisal, the value of the
acquired Odisei in-process research and development, which was expensed in the
fiscal year ended March 31, 2000, was $10.1 million. The excess of the purchase
price over the net tangible and intangible assets acquired and liabilities
assumed was allocated to goodwill. Amounts allocated to goodwill and workforce
are being amortized on a straight-line basis over five and three years,
respectively. The allocation of the purchase price was as follows (in
thousands):
In-process research and development........................ $10,100
Workforce.................................................. 200
Net tangible liabilities................................... (219)
Goodwill................................................... 3,481
-------
$13,562
=======
Our consolidated financial statements for the fiscal year ended March 31,
2000 include the results of Odisei from the date of acquisition.
Amortization of intangible assets charged to operations was $11.0 million
and $614,000 during the fiscal years ended March 31, 2001 and 2000,
respectively.
Restructuring Charges
During the fourth quarter of fiscal 2001, after a significant number of
employees had resigned, we discontinued our Canadian operations acquired in
conjunction with the acquisition of U/Force in June 2000. We closed our offices
in Montreal and Hull, Quebec and laid-off all remaining employees resulting in
the cessation of most of the research and development efforts and all of the
sales and marketing and professional services activities associated with the
U/Force business. As a result of the restructuring, we recorded a one-time
charge of $33.3 million in the quarter ended March 31, 2001. The restructuring
charges consisted of the following (in thousands):
Employee separation........................................ $ 765
Fixed asset losses and impairments......................... 2,084
Intangible asset impairments............................... 30,247
Lease obligation and termination........................... 220
-------
$33,316
=======
Employee separation costs represent severance payments related to the 96
employees in the Montreal and Hull offices who were laid-off.
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The impairment charges for fixed assets of approximately $2.1 million
included write-offs of abandoned and unusable assets of approximately $1.4
million, a loss on sale of assets of $567,000, and a charge for assets to be
disposed of $172,000. The loss on sale of assets of $567,000 was attributable to
the sale of office, computer, and other equipment of the Montreal office. We
received common stock of the purchaser valued at approximately $412,000 as of
the date of sale. Fair value of assets to be disposed was measured based on
expected salvage value, less costs to sell. These assets are expected to be sold
or abandoned, depending on re-sale market conditions, within the next six to
twelve months.
The impairment charges for intangible assets represented the write-off of
the unamortized intangible assets recorded in connection with the acquisition of
U/Force. The charges of approximately $30.2 million included: $28.7 million for
the goodwill related to the acquisition, $739,000 for the assembled workforce,
and $789,000 related to a distribution agreement. The impairments were directly
attributable to the cessation of operations in Canada. We performed an
evaluation of the recoverability of the intangible assets related to these
operations in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The lack of
estimated future net cash flows related to the acquired products necessitated an
impairment charge to write-off the remaining unamortized goodwill. The
distribution agreement asset was written off because we will no longer provide
products and services to customers under that agreement.
In March 2001 we terminated the lease for our primary facility in Montreal.
Pursuant to the lease termination agreement, we are obligated to pay rent on the
Montreal facility through May 31, 2001. We recorded charges for this rental
obligation as well as the related lease termination costs. We are actively
seeking a third party to sublet our vacant facility in Hull, Quebec, and have
recorded a charge for estimated lease termination and related costs.
Cash payments related to the restructuring, which included all employee
separation costs and certain lease termination costs, approximated $920,000
during our fourth fiscal quarter ended March 31, 2001. As of March 31, 2001, the
remaining estimated cash requirements of approximately $215,000 are related to
lease obligations and anticipated lease termination costs.
The restructuring and discontinuation of our Canadian operations will
reduce our operating expenses and cash used in operations beginning in fiscal
2002. From June 30, 2000 (date of acquisition of U/Force) to March 31, 2001, we
incurred operating expenses, excluding restructuring charges, of approximately
$7.0 million, and net cash outflows of approximately $10 million related to our
Canadian operations. As a result of the cessation of operations in Canada, we do
not expect to incur significant related operating expenses or cash outflows in
fiscal 2002.
Other Income, Net
In fiscal 2001, 2000, and 1999, other income, net, was approximately $2.6
million, $2.8 million, and $1.0 million, respectively. The decrease in other
income, net, in fiscal 2001 compared to fiscal 2000 was due primarily to a $1.7
million decrease in gains realized from the sale of equity investments, offset
by an increase in interest income resulting from higher average cash equivalent
and short-term investment balances as compared to fiscal 2000. The increase in
other income, net, in fiscal 2000 as compared to fiscal 1999 was due primarily
to a $1.9 million gain realized from the sale of an equity investment, offset by
approximately $205,000 of losses realized on the sale of certain of investments
classified as available-for-sale.
Interest Expense
Interest expense increased from $391,000 in fiscal 2000 to $1.4 million in
fiscal 2001 due primarily to an increase in interest charges and amortization of
both the debt discount and debt issuance costs associated with the convertible
subordinated debentures issued in December 1999.
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Provision for Income Taxes
The provisions of $17,000 and $120,000 for the years ended March 31, 2001
and 2000, respectively, represent certain foreign taxes. There was no tax
provision for the year ended March 31, 1999 due to the net losses incurred.
At March 31, 2001, we had net operating loss carryforwards for federal and
state income tax purposes of approximately $61.4 million and $38.7 million,
respectively, which expire at various dates beginning in 2005. In addition, at
March 31, 2001, we had research and development credit carryforwards for federal
and state tax reporting purposes of approximately $2.9 million and $2.1 million,
respectively. The federal credit carryforwards will begin expiring in 2010 while
the California credit will carryforward indefinitely. Under the ownership change
limitations of the Internal Revenue Code of 1986, as amended, the amount and
benefit from the net operating losses and credit carryforwards may be impaired
or limited in certain circumstances.
At March 31, 2001, we had gross deferred tax assets of approximately $47.7
million. We believe that, based on a number of factors, the weight of objective
available evidence indicates that it is more likely than not that we will not be
able to realize our deferred tax assets, and thus a full valuation allowance was
recorded at March 31, 2001 and March 31, 2000.
Cumulative Effect of Change in Accounting Principle
In November 2000, the Financial Accounting Standards Board (FASB) Emerging
Issues Task Force reached several conclusions regarding the accounting for debt
and equity securities with beneficial conversion features, including a consensus
requiring the application of the "accounting conversion price" method, versus
the use of the stated conversion price, to calculate the beneficial conversion
feature for such securities. The Securities and Exchange Commission required
companies to record a cumulative catch-up adjustment in the fourth quarter of
calendar 2000 related to the application of the "accounting conversion price"
method to securities issued after May 21, 1999. Accordingly, we recorded a $1.1
million non-cash expense during the quarter ended December 31, 2000 to account
for a beneficial conversion feature associated with the convertible subordinated
debentures and related warrants issued in December 1999, and we have presented
it as a cumulative effect of a change in accounting principle.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities." SFAS 133 establishes methods of accounting for derivative financial
instruments and hedging activities related to those instruments as well as other
hedging activities. We are required to adopt SFAS 133 in the first quarter of
fiscal 2002 pursuant to the issuance of SFAS 137, "Accounting for Derivative
Instruments and Hedging Activities -- Deferral of the Effective Date of FASB
Statement No. 133," which deferred the effective date of SFAS 133 by one year.
In June 2000, the FASB issued SFAS No. 138 (SFAS 138), "Accounting for Certain
Derivative Instruments and Certain Hedging Activities -- an amendment of FASB
statement No. 133," which amends certain terms and conditions of SFAS 133. We do
not expect that the adoption of SFAS 133, as amended, will have a material
impact on our consolidated financial statements.
Liquidity and Capital Resources
As of March 31, 2001, we had cash and cash equivalents totaling $24.1
million, representing a decrease of $24.5 million from March 31, 2000. We
currently have no borrowing arrangements.
Cash used in operations of $24.6 million in fiscal 2001 reflected a net
loss of $74.4 million, decreases in accounts payable and accrued compensation of
$2.2 million and $623,000, an increase in other current and non-current assets
of $1.3 million, and a non-cash adjustment for a gain on sale of investments of
$225,000. Cash used in operations was partially offset by cash provided by a
decrease in accounts receivable of $851,000, an increase in other accrued
liabilities of $378,000, and non-cash items, including restructuring charges of
$32.3 million, depreciation and amortization of $14.4 million, in-process
research and development of
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$4.6 million, the cumulative effect of a change in accounting principle of $1.1
million, and stock compensation charges of $753,000. Cash provided by investing
activities in fiscal 2001 is primarily attributable to net proceeds from the
sale of assets and the license of technology associated with our video
monitoring line of $5.2 million, offset by acquisitions of property and
equipment of $6.1 million and cash paid for acquisitions, net, of $558,000. Cash
flows from financing activities in fiscal 2000 consisted primarily of proceeds
from sales of the Company's common stock totaling $2.8 million, offset by debt
repayments of $891,000 and repurchases of common stock and Exchangeable Shares
of $514,000. For the year, cash and cash equivalents decreased $24.5 million.
Cash used in operations of $4.1 million in fiscal 2000 reflected a net loss
of $24.8 million, a decrease in deferred revenue of $3.4 million, and a non-cash
adjustment for a gain on sale of investments, net, of $1.7 million. Cash used in
operations was partially offset by cash provided by a decrease in accounts
receivable of $3.5 million, a decrease in inventory of $2.5 million, and
non-cash items, including depreciation and amortization of $2.1 million,
in-process research and development of $10.1 million, and discount on issuance
of common stock of $7.4 million. Cash provided by investing activities in fiscal
2000 is attributable to proceeds from the sale of an investment of $1.9 million,
offset by acquisitions of property and equipment of $1.7 million and cash paid
for acquisitions, net, of $149,000. Cash flows from financing activities in
fiscal 2000 consisted primarily of proceeds from the sale of convertible
subordinated debentures of $7.5 million and sales of the Company's common stock
totaling $29.8 million, offset by debt issuance costs of $617,000. For the year,
cash and cash equivalents increased $32.8 million.
Cash used in operations of $10.4 million in fiscal 1999 reflected a net
loss of $19.2 million, an increase in accounts receivable of $1.4 million, and a
decrease in accounts payable of $708,000. Cash used in operations was partially
offset by cash provided by a decrease in inventory of $8.8 million, an increase
in deferred revenue of $1.6 million, and non-cash items, including stock
compensation expense of $416,000 and depreciation and amortization of $967,000.
Cash used in investing activities in fiscal 1999 is primarily attributable to
capital expenditures of $1.8 million. Cash flows from financing activities in
fiscal 1999 consisted primarily of net proceeds from the repayment of
stockholders' notes receivable and sales of the Company's common stock upon the
exercise of employee stock options. For the year, cash and cash equivalents
decreased by $10.9 million.
As of March 31, 2001, our principal commitments consisted of obligations
outstanding under noncancelable operating leases.
We believe that our current cash and cash equivalents, and cash generated
from operations, if any, will satisfy our expected working capital and capital
expenditure requirements through at least the next 12 months. We may, however,
need additional working capital shortly thereafter. Accordingly, we may raise
additional financing at some point during the next twelve months in order to
meet our cash requirements for fiscal 2003. We will be evaluating financing
alternatives prior to that time. We may also seek to explore business
opportunities, including acquiring or investing in complementary businesses or
products that will require additional capital from equity or debt sources.
Additionally, the development and marketing of new products could require a
significant commitment of resources, which could in turn require us to obtain
additional financing earlier than otherwise expected. We may not be able to
obtain additional financing as needed on acceptable terms, or at all, which may
require us to reduce our operating costs and other expenditures, including
reductions of personnel and suspension of salary increases and capital
expenditures. Alternatively, or in addition to such potential measures, we may
elect to implement other cost reduction actions as we may determine are
necessary and in our best interests, including the possible sale or cessation of
certain of our business lines. Any such actions undertaken might limit our
opportunities to realize plans for revenue growth and we might not be able to
reduce our costs in amounts sufficient to achieve break-even or profitable
operations.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
WE MAY NEED TO RAISE ADDITIONAL CAPITAL TO SUPPORT OUR GROWTH, AND FAILURE TO DO
SO IN A TIMELY MANNER MAY CAUSE US TO DELAY OUR PLANS FOR GROWTH OR CAUSE US TO
IMPLEMENT ADDITIONAL COST REDUCTION STRATEGIES
As of March 31, 2001, we had approximately $24.1 million in cash and cash
equivalents. We believe that our current cash and cash equivalents, and cash
generated from operations, if any, will satisfy our expected working capital and
capital expenditure requirements through at least the next twelve months. We
may, however, need additional working capital shortly thereafter. Accordingly,
we may seek additional financing at some point during the next twelve months in
order to meet our cash requirements in fiscal 2003. We may also seek to explore
business opportunities, including acquiring or investing in complementary
businesses or products that will require additional capital from equity or debt
sources. Additionally, the development and marketing of new products could
require a significant commitment of resources, which could in turn require us to
obtain additional financing earlier than otherwise expected. We may not be able
to obtain additional financing as needed on acceptable terms, or at all, which
may require us to reduce our operating costs and other expenditures, including
reductions of personnel and suspension of salary increases and capital
expenditures. Alternatively, or in addition to such potential measures, we may
elect to implement other cost reduction actions as we may determine are
necessary and in our best interests, including the possible sale or cessation of
certain of our business lines. Any such actions undertaken might limit our
opportunities to realize plans for revenue growth and we might not be able to
reduce our costs in amounts sufficient to achieve break-even or profitable
operations. If we issue additional equity or convertible debt securities to
raise funds, the ownership percentage of our existing stockholders would be
reduced. New investors may demand rights, preferences or privileges senior to
those of existing holders of our common stock.
WE HAVE A HISTORY OF LOSSES AND WE ARE UNCERTAIN AS TO OUR FUTURE PROFITABILITY
We recorded an operating loss of $74.4 million for the fiscal year ended
March 31, 2001 and had an accumulated deficit of $128.1 million at March 31,
2001. In addition, we recorded operating losses for the fiscal years ended March
31, 2000 and 1999. We expect that Netergy, as well as its subsidiaries
individually, will continue to incur operating losses for the foreseeable
future, and such losses may be substantial. We will need to generate significant
revenue growth to achieve profitability. Given our history of fluctuating
revenues and operating losses, we cannot be certain that we will be able to
achieve profitability on either a quarterly or annual basis.
THE GROWTH OF OUR BUSINESS AND FUTURE PROFITABILITY DEPENDS ON FUTURE IP
TELEPHONY REVENUE
We believe that our business and future profitability will be largely
dependent on widespread market acceptance of our IP telephony products. Our
videoconferencing semiconductor business has not provided, nor is it expected to
provide, sufficient revenues to profitably operate our business. To date, we
have not generated significant revenue from the sale of our IP telephony
products. If we are not able to generate significant revenues selling into the
IP telephony market, our business and operating results would be seriously
harmed.
Success of our IP telephony product strategy assumes that there will be
future demand for IP telephony systems. In order for the IP telephony market to
continue to grow, several things need to occur. Telephone service providers must
continue to invest in the deployment of high speed broadband networks to
residential and commercial customers. IP networks must improve quality of
service for real-time communications, managing effects such as packet jitter,
packet loss, and unreliable bandwidth, so that toll-quality service can be
provided. IP telephony equipment must achieve the 99.999% reliability that users
of the PSTN have come to expect from their telephone service. IP telephony
service providers must offer cost and feature benefits to their customers that
are sufficient to cause the customers to switch away from traditional telephony
service providers. If any or all of these factors fail to occur, our business
may not grow.
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OUR FUTURE OPERATING RESULTS MAY NOT FOLLOW PAST OR EXPECTED TRENDS DUE TO MANY
FACTORS AND ANY OF THESE COULD CAUSE OUR STOCK PRICE TO FALL
Our historical operating results have fluctuated significantly and will
likely continue to fluctuate in the future, and a decline in our operating
results could cause our stock price to fall. On an annual and a quarterly basis,
there are a number of factors that may affect our operating results, many of
which are outside our control. These include, but are not limited to:
- changes in market demand;
- the timing of customer orders;
- competitive market conditions;
- lengthy sales cycles and/or regulatory approval cycles;
- new product introductions by us or our competitors;
- market acceptance of new or existing products;
- the cost and availability of components;
- the mix of our customer base and sales channels;
- the mix of products sold;
- the management of inventory;
- the level of international sales;
- continued compliance with industry standards; and
- general economic conditions.
Our gross margin is affected by a number of factors including, product mix,
the recognition of license and other revenues for which there may be little or
no corresponding cost of revenues, product pricing, the allocation between
international and domestic sales, the percentage of direct sales and sales to
resellers, and manufacturing and component costs. The markets for our products
are characterized by falling average selling prices. We expect that, as a result
of competitive pressures and other factors, gross profit as a percentage of
revenue for our videoconferencing semiconductor products will continue to
decrease for the foreseeable future. Average selling prices (ASPs) realized to
date for our IP telephony semiconductors have been lower than those historically
attained for our multimedia communication semiconductor products resulting in
lower gross margins. In the likely event that we encounter significant price
competition in the markets for our products, we could be at a significant
disadvantage compared to our competitors, many of whom have substantially
greater resources, and therefore may be better able to withstand an extended
period of downward pricing pressure.
Variations in timing of sales may cause significant fluctuations in future
operating results. In addition, because a significant portion of our business
may be derived from orders placed by a limited number of large customers,
including OEM customers, the timing of such orders can also cause significant
fluctuations in our operating results. Anticipated orders from customers may
fail to materialize. Delivery schedules may be deferred or canceled for a number
of reasons, including changes in specific customer requirements or international
economic conditions. The adverse impact of a shortfall in our revenues may be
magnified by our inability to adjust spending to compensate for such shortfall.
Announcements by our competitors or us of new products and technologies could
cause customers to defer purchases of our existing products, which would also
have a material adverse effect on our business and operating results.
As a result of these and other factors, it is likely that in some or all
future periods our operating results will be below the expectations of
securities analysts or investors, which would likely result in a significant
reduction in the market price of our common stock.
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WE MAY NOT BE ABLE TO MANAGE OUR INVENTORY LEVELS EFFECTIVELY, WHICH MAY LEAD TO
INVENTORY OBSOLESCENCE THAT WOULD FORCE US TO LOWER OUR PRICES
Our products have lead times of up to several months, and are built to
forecasts that are necessarily imprecise. Because of our practice of building
our products to necessarily imprecise forecasts, it is likely that, from time to
time, we will have either excess or insufficient product inventory. Excess
inventory levels would subject us to the risk of inventory obsolescence and the
risk that our selling prices may drop below our inventory costs, while
insufficient levels of inventory may negatively affect relations with customers.
Any of these factors could have a material adverse effect on our business,
operating results, and financial condition.
WE DEPEND ON PURCHASE ORDERS FROM KEY CUSTOMERS AND FAILURE TO RECEIVE
SIGNIFICANT PURCHASE ORDERS IN THE FUTURE WOULD CAUSE A DECLINE IN OUR OPERATING
RESULTS
Historically, a significant portion of our sales has been to relatively few
customers, although the composition of these customers has varied. Revenues from
our ten largest customers for the fiscal years ended March 31, 2001, 2000, and
1999 accounted for approximately 48%, 35%, and 40%, respectively, of total
revenues. Substantially all of our product sales have been made, and are
expected to continue to be made, on a purchase order basis. None of our
customers has entered into a long-term agreement requiring it to purchase our
products. In the future, we will need to gain purchase orders for our products
to earn additional revenue. Further, substantially all of our license and other
revenues are nonrecurring.
THE IP TELEPHONY MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND WE DEPEND
ON NEW PRODUCT INTRODUCTION IN ORDER TO MAINTAIN AND GROW OUR BUSINESS
IP telephony is an emerging market that is characterized by rapid changes
in customer requirements, frequent introductions of new and enhanced products,
and continuing and rapid technological advancement. To compete successfully in
this emerging market, we must continue to design, develop, manufacture, and sell
new and enhanced semiconductor and IP telephony software products that provide
increasingly higher levels of performance and reliability at lower cost. These
new and enhanced products must take advantage of technological advancements and
changes, and respond to new customer requirements. Our success in designing,
developing, manufacturing, and selling such products will depend on a variety of
factors, including:
- the identification of market demand for new products;
- product and feature selection;
- timely implementation of product design and development;
- product performance;
- cost-effectiveness of products under development;
- effective manufacturing processes; and
- success of promotional efforts.
Additionally, we may also be required to collaborate with third parties to
develop our products and may not be able to do so on a timely and cost-effective
basis, if at all. We have in the past experienced delays in the development of
new products and the enhancement of existing products, and such delays will
likely occur in the future. If we are unable, due to resource constraints or
technological or other reasons, to develop and introduce new or enhanced
products in a timely manner, if such new or enhanced products do not achieve
sufficient market acceptance, or if such new product introductions decrease
demand for existing products, our operating results would decline and our
business would not grow.
THE LONG AND VARIABLE SALES AND DEPLOYMENT CYCLES FOR OUR IP TELEPHONY SOFTWARE
PRODUCTS MAY CAUSE OUR REVENUE AND OPERATING RESULTS TO VARY
Our IP telephony software products, including our hosted iPBX and SCE
products, have lengthy sales cycles, and we may incur substantial sales and
marketing expenses and expend significant management effort
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without making a sale. A customer's decision to purchase our products often
involves a significant commitment of its resources and a lengthy product
evaluation and qualification process. In addition, the length of our sales
cycles will vary depending on the type of customer to whom we are selling and
the product being sold. Even after making the decision to purchase our products,
our customers may deploy our products slowly. Timing of deployment can vary
widely and will depend on various factors, including:
- the size of the network deployment;
- the complexity of our customers' network environments;
- our customers' skill sets;
- the hardware and software configuration and customization necessary to
deploy our products; and
- our customers' ability to finance their purchase of our products.
As a result, it is difficult for us to predict the quarter in which our
customers may purchase our products, and our revenue and operating results may
vary significantly from quarter to quarter.
IF OUR PRODUCTS DO NOT INTEROPERATE WITH OUR CUSTOMERS' NETWORKS, ORDERS FOR OUR
PRODUCTS WILL BE DELAYED OR CANCELED AND SUBSTANTIAL PRODUCT RETURNS COULD
OCCUR, WHICH COULD HARM OUR BUSINESS
Many of the potential customers for our hosted iPBX and unified messaging
products have requested that our products be designed to interoperate with their
existing networks, each of which may have different specifications and use
multiple standards. Our customers' networks may contain multiple generations of
products from different vendors that have been added over time as their networks
have grown and evolved. Our products must interoperate with these products as
well as with future products in order to meet our customers' requirements. In
some cases, we may be required to modify our product designs to achieve a sale,
which may result in a longer sales cycle, increased research and development
expense, and reduced operating margins. If our products do not interoperate with
existing equipment or software in our customers' networks, installations could
be delayed, orders for our products could be canceled or our products could be
returned. This could harm our business, financial condition, and results of
operations.
INTENSE COMPETITION IN THE MARKETS IN WHICH WE COMPETE COULD P